Dividing retirement accounts in divorce is often confusing and complex for many many couples going through a divorce in Illinois. Dividing retirement accounts – 401(k)s, pension plans, IRAs, etc. – like any other assets to be divided in an Illinois divorce follow the rules of equitable division of marital property.
The General Rules of Property Division
As mentioned in prior blog posts, Illinois is not a “community property state”; it is an “equitable distribution” state. In a “community property” state there is a presumption that all marital property will be divided equally. In Illinois, we provide an “equitable division” of said marital property, based upon certain factors and criteria. Equitable is not always equal.
Generally, in Illinois marital property can be divided disproportionately in when there is a lengthy marriage, a disproportionate future earning capacity, when the parties have significant age difference, as well as when many other factors are present. However, in Illinois retirement accounts are generally divided without much regard to those specific factors.
Why is Retirement often Divided Differently than other Marital Assets?
While there is no “set in stone” rule about how retirement accounts are to be divided, many Judges in Illinois divide them 50/50, despite other marital property being divided disproportionately. There are many reasons why this might occur. First, at the time of retirement, no one is working, and both parties may be drawing on the same social security, depending upon the years of marriage, any remarriages, etc. But generally speaking, the parties, at the time of retirement, are on so called “equal footing” because no one is employed. The marital share of the retirement, thus, can be divided equally between the parties. However, it is not impossible to obtain a disproportionate share of retirement accounts, it is just very rare and reserved for extenuating circumstances.
Will I be Charged a Penalty or Taxes for Dividing a Retirement Account in my Divorce?
The answer to this common question is Maybe.
Paying a penalty or incurring a tax will depend upon what type of account is being divided. Generally speaking, IRA accounts can be rolled over from one person to another without a special order or significant financial consequences. However, 401(k) accounts and Pensions have to be divided pursuant to Qualified Order. Some IRAs require a qualified order for division, though less common.
Dividing 401(k) Accounts and Qualified Domestic Relations Order (QDRO)
The purpose of dividing a 401(k) using a Qualified Order is to avoid any tax consequences or penalties when transferring a share of said account to the other party. Some retirement plans have different requirements than others. In most plans, so long as the Qualified Domestic Relations Order (“QDRO”) is drafted properly, signed by the Judge and certified, it will allow the transfer of a portion of the 401K account into a separate retirement account established in the name of the other party. The transfer from one account to another using a QDRO waives the typical 10% penalty for an early withdrawal.
Sometimes QDROs can allow the person who the account is being transferred to, to take out a portion of said account in cash. In this scenario, the plan administrator and plan documents must allow for this within the way the plan was initially set up, and not all plans allow this. Additionally, while these funds typically will not be subjected to a 10% penalty, the person receiving the funds as cash will still have to pay the appropriate taxes on the disbursement in accordance with their income tax bracket. However, rolling the share from the 401(k) account into a separate retirement account, where no cash is withdrawn, usually prohibits tax consequences from occurring.
What about Dividing Pensions in Divorce?
Dividing pension plans is different than other retirement accounts. Pensions are not defined benefits. There generally is not an account sitting somewhere with a defined amount in it to be divided. The value of a pension typically involves many factors, including but not limited to the length of the employee’s employment.
Typically, dividing a pension plan in Illinois involves a “Qualified Illinois Domestic Relations Order” (QILDRO) at the time the divorce is finalized. But, the QILDRO really only serves to notify the pension plan administrator that there is a share of the pension plan that belongs to a spouse. Usually, a Calculation Order must be entered by the Judge at the time of the participant’s retirement so that the pension plan knows how much to pay the now ex-spouse. This means if a share of your ex-spouse’s pension account was awarded to you in a divorce, you will need to seek legal input when your ex-spouse is ready to retire.
Dividing assets in a divorce can be complicated, especially when a couple has multiple retirement investment accounts that include a mix like pension plans and 401(k) accounts. Be sure your rights to and share of pension plans and 401(k)s are protected in your divorce. Feel free to contact Anderson & Boback when you need accurate legal advice from family law attorneys with deep expertise in dividing retirement accounts in divorce.